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October 26, 2012

Obamacare Here to Stay Even With GOP Victory, Analysts Say

Morningstar research report says that budget sequestration will have the biggest impact on healthcare sector stocks

A family waits in a health clinic. (Photo: AP)

Regardless of which party claims the greatest victory in November elections, Obamacare is likely to remain in place and so too will valuations of healthcare sector stocks, Morningstar stock analysts say in a new report.

The report, written by Morningstar healthcare sector analysts Damien Conover, Alex Morozov and Karen Andersen, acknowledges that the impact of government is important enough to influence investor sentiment within the sector, initially.

A GOP sweep would favor pharmaceutical and medical device firms, they say, while Democrats retaining power would bolster health care providers.

"However, the impact on individual stock valuations generally isn’t material regardless of who wins the election," the analysts write.

Rather, the key catalyst for the entire sector will be the outcome of budget sequestration. A failure to avert automatic cuts to Medicare provider rates set to take effect at the start of 2013 will be a strong negative for sector stocks. Healthcare providers and life science research firms will be hurt the most, the former because already low reimbursement rates will further decline and the latter because an end to new NIH grants will suppress demand for life science research “instrumentation and consumables.”

“The sequestration’s main implication for the healthcare sector is a blunt 2% cut to Medicare provider rates, applied indiscriminately,” the Morningstar analysts write.

While a last-minute budget compromise remains possible, “election year politics and a lame duck Congress in the last two months of calendar 2012 shorten the window for a possible solution,” the analysts write, adding that as a result they “have started incorporating a se­questration scenario into our models.”

Consequently, valuation for a medical device firm like Medtronic (MDT), which has a relatively low level (23% of sales) of exposure to Medicare reimbursement, was cut just 5% by the Morningstar analysts, whereas Boston Scientific (BSX), with a higher level of Medicare exposure (33% of sales), was cut 15%.

Healthcare providers are far more affected by sequestration cuts than medical device firms, however, accounting for 45% of total budget savings, for which reason the Morningstar analysts cut valuations for companies like Kindred (KND) and Select Medical (SEM).

But the negative impact of sequestration on the sector could be magnified by a GOP victory since “some Republicans are agitating to preserve military spending from any cuts, which would force larger cuts in the non-military budgets. If the Republicans were able to gain agreement for their plan, then we would see an even larger reduction to our valuations on the heels of deeper cuts to Medicare reimbursement,” the analysts write.

The analysts say sequestration would have its most minimal impact on pharmaceutical and biotech companies, since drug makers – except for Amgen – have limited exposure to Medicare, adding that Republican rule would be a net positive for this industry segment.

Perhaps the most surprising part of the Morningstar report, however, is their view that a Romney victory is unlikely to result in repeal of Obamacare, despite the Republican presidential hopeful’s numerous declarations to do that on “Day One” in the White House.

“The biggest question is whether the implementation of certain elements of [Obamacare] and the removal of others would be possible, considering the interconnected nature of many provisions of the bill. ... Our take at this juncture is that despite Republican efforts, [Obamacare] is, by and large, here to stay,” the authors write.

They add that since Republicans are unlikely to gain a 60-vote supermajority in the Senate, any changes made to President Obama’s healthcare law through the reconciliation process are unlikely to reach fundamentals of the law, such as the individual mandate. The U.S. Supreme Court’s 5-4 decision upholding the mandate would further weaken chances of repeal, they say.